**UNITEDSTATES SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

 

 

**FORM 10-QSB**

 

| x                                                                                                                                                             | **QUARTERLY  REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------|-----------------------------------------------------------------------------------------|
| **For the  quarter ended January 31, 2008**                                                                                                                   |
| ** **                                                                                                                                                    | ** **                                                                              |
| o                                                                                                                                                             | **TRANSITION  REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
| **For the  transition period from          to          ** |
| ** **                                                                                                                                                    | ** **                                                                              |
| **Commission  File No. 1-8125**                                                                                                                               |

 

 

**TOROTEL,INC.**

(Exact name ofsmall business issuer as specified in its charter)

 

 

| **MISSOURI**                     | ** ** | **44-0610086**                        |
|----------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction of |       | (I.R.S. Employer  Identification No.) |
| incorporation or  organization)  |       |                                  |

 

**620NORTH LINDENWOOD DRIVE, OLATHE, KANSAS 66062**

(Address ofprincipal executive offices)

 

**(913)747-6111**

(Issuer’stelephone number)

 

**NONE**

(Former name,former address and former fiscal year, if changed since last report)

 

 

Check whether theissuer (1) filed all reports required to be filed by Section 13 or 15(d) ofthe Exchange Act during the past 12 months and (2) has been subject tosuch filing requirements for the past 90 days.

 

Yes x   No o

 

Check whether the issueris a shell company (as defined in Rule 12b-2 of the Exchange Act.)

 

Yes o   No x

 

As of March 13,2008, there were 5,878,340 shares of Common Stock, $.01 par value, outstanding.

 

Transitional small businessformat:  Yes o   No x

 

 

----

 

 

TOROTEL, INC. ANDSUBSIDIARIES

 

INDEX

 

 
| PART I.   FINANCIAL  INFORMATION |                                                                                                              |
|------------------------------------------------------|-------------------------------------------------------------------------------------------------------------------|
|                                                 |                                                                                                              |   |   |
|                                                 | Item  1.       Financial Statements                                            |   |
|                                                 |                                                                                                              |   |   |
|                                                 |                                                                                                              | Consolidated Balance Sheet  as of January 31, 2008 | 1 |
|                                                 |                                                                                                              |   |   |
|                                                 |                                                                                                              | Consolidated Statements of  Operations for the nine months ended January 31, 2008 and 2007 | 2 |
|                                                 |                                                                                                              |   |   |
|                                                 |                                                                                                              | Consolidated Statements of  Operations for the three months ended January 31, 2008 and 2007 | 3 |
|                                                 |                                                                                                              |   |   |
|                                                 |                                                                                                              | Consolidated  Statements of Cash Flows for the nine months ended January 31, 2008 and  2007 | 4 |
|                                                 |                                                                                                              |   |   |
|                                                 |                                                                                                              | Notes to  Consolidated Financial Statements | 5 |
|                                                 |                                                                                                              |   |   |
|                                                 | Item  2.       Management’s Discussion and  Analysis or Plan of Operation | 13 |
|                                                 |                                                                                                              |   |   |
|                                                 | Item  3.       Controls and Procedures                                         | 21 |
|                                                 |                                                                                                              |   |   |
|                                                 |                                                                                                              |   |   |
| PART II.   OTHER  INFORMATION    |                                                                                                              |
|                                                 |                                                                                                              |   |   |
|                                                 | Item  4.       Submission of Matters to a Vote  of Security Holders            | 22 |
|                                                 |                                                                                                              |   |   |
|                                                 | Item  6.       Exhibits                                                        | 23 |
|                                                 |                                                                                                              |   |   |
|                                                 |                                                                                                              |   |   |
| SIGNATURES                                           | 24                                                                                                                |
|                                                      |                                                                                                                   |  |  |  |

 

 

----

 

**PART I.     FINANCIAL INFORMATION**

 

**Item1.       Financial Statements**

 

**CONSOLIDATEDBALANCE SHEET (Unaudited)**

As of January 31,2008

 
| ASSETS                                     |   |      |      |
|--------------------------------------------|--------|-----------|-----------|
|                                       |   |      |      |
| Current assets:                            |   |      |      |
| Cash                                       |   | $         | 313,000   |   |
| Accounts  receivable, net                  |   | 650,000   |      |
| Inventories                                |   | 501,000   |      |
| Prepaid expenses  and other current assets |   | 37,000    |      |
|                                       |   | 1,501,000 |      |
|                                       |   |      |      |
| Property, plant and equipment, net         |   | 1,007,000 |      |
|                                       |   |      |      |
| Other assets                               |   | 3,000     |      |
|                                       |   |      |      |
|                                       |   | $         | 2,511,000 |   |
|                                       |   |      |      |
| LIABILITIES AND STOCKHOLDERS’ EQUITY  |   |      |      |
|                                       |   |      |      |
| Current liabilities:                       |   |      |      |
| Current  maturities of long-term debt      |   | $         | 62,000    |   |
| Trade accounts  payable                    |   | 146,000   |      |
| Accrued  liabilities                       |   | 250,000   |      |
|                                       |   | 458,000   |      |
|                                       |   |      |      |
| Long-term debt, less current maturities    |   | 664,000   |      |
|                                       |   |      |      |
| Stockholders’ equity                  |   | 1,389,000 |      |
|                                       |   |      |      |
|                                       |   | $         | 2,511,000 |   |

 

The accompanyingnotes are an integral part of this statement.

 

 

1

----

 

**CONSOLIDATEDSTATEMENTS OF OPERATIONS (Unaudited)**

Nine Months Ended January 31,

 
| ** **                                                                                                  | ** ** | **2008**  | ** ** | **2007**  | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|-----------|------------|-----------|------------|
| Net sales                                                                                                   |       | $         | 4,441,000  |      | $          | 3,631,000 |   |
| Cost of goods sold                                                                                          |       | 2,623,000 |       | 2,278,000 |       |
|                                                                                                        |       |      |       |      |       |
| Gross profit                                                                                                |       | 1,818,000 |       | 1,353,000 |       |
|                                                                                                        |       |      |       |      |       |
| Operating expenses:                                                                                         |       |      |       |      |       |
| Engineering                                                                                                 |       | 196,000   |       | 193,000   |       |
| Selling, general  and administrative                                                                        |       | 1,550,000 |       | 1,415,000 |       |
| Amortization of  intangible assets                                                                          |       | —    |       | 27,000    |       |
|                                                                                                        |       | 1,746,000 |       | 1,635,000 |       |
|                                                                                                        |       |      |       |      |       |
| Earnings (loss)  from operations                                                                            |       | 72,000    |       | (282,000  | )          |
|                                                                                                        |       |      |       |      |       |
| Other expense (income):                                                                                     |       |      |       |      |       |
| Interest expense                                                                                            |       | 46,000    |       | 86,000    |       |
| Interest income                                                                                             |       | —    |       | (7,000    | )          |
|                                                                                                        |       | 46,000    |       | 79,000    |       |
|                                                                                                        |       |      |       |      |       |
| Earnings (loss)  before provision for income taxes and cumulative effect of change in  accounting principle |       | 26,000    |       | (361,000  | )          |
|                                                                                                        |       |      |       |      |       |
| Provision for income taxes                                                                                  |       | —    |       | —    |       |
|                                                                                                        |       |      |       |      |       |
| Earnings (loss)  before cumulative effect of change in accounting principle                                 |       | 26,000    |       | (361,000  | )          |
|                                                                                                        |       |      |       |      |       |
| Cumulative effect of change in accounting principle                                                         |       | —    |       | 8,000     |       |
|                                                                                                        |       |      |       |      |       |
| Net earnings (loss)                                                                                         |       | $         | 26,000     |      | $          | (353,000 | ) |
|                                                                                                        |       |      |       |      |       |
| Basic earnings (loss) per share:                                                                            |       |      |       |      |       |
| Before  cumulative effect                                                                                   |       | $         | .00        |      | $          | (.07 | ) |
| Cumulative  effect                                                                                          |       | —    |       | —    |       |
|                                                                                                        |       | $         | .00        |      | $          | (.07 | ) |
|                                                                                                        |       |      |       |      |       |
| Diluted earnings (loss) per share:                                                                          |       |      |       |      |       |
| Before  cumulative effect                                                                                   |       | $         | .00        |      | $          | (.07 | ) |
| Cumulative  effect                                                                                          |       | —    |       | —    |       |
|                                                                                                        |       | $         | .00        |      | $          | (.07 | ) |

 

The accompanyingnotes are an integral part of these statements.

 

 

2

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**CONSOLIDATEDSTATEMENTS OF OPERATIONS (Unaudited)**

Three Months Ended January 31,

 
| ** **                                         | ** ** | **2008** | ** ** | **2007** | ** ** |
|----------------------------------------------------|------------|----------|------------|----------|------------|
| Net sales                                          |       | $        | 1,392,000  |     | $          | 1,145,000 |   |
| Cost of goods sold                                 |       | 824,000  |       | 713,000  |       |
|                                               |       |     |       |     |       |
| Gross profit                                       |       | 568,000  |       | 432,000  |       |
|                                               |       |     |       |     |       |
| Operating expenses:                                |       |     |       |     |       |
| Engineering                                        |       | 65,000   |       | 64,000   |       |
| Selling, general  and administrative               |       | 422,000  |       | 473,000  |       |
| Amortization of  intangible assets                 |       | —   |       | 16,000   |       |
|                                               |       | 487,000  |       | 553,000  |       |
|                                               |       |     |       |     |       |
| Earnings (loss)  from operations                   |       | 81,000   |       | (121,000 | )          |
|                                               |       |     |       |     |       |
| Other expense (income):                            |       |     |       |     |       |
| Interest expense                                   |       | 15,000   |       | 29,000   |       |
| Interest income                                    |       | —   |       | (2,000   | )          |
|                                               |       | 15,000   |       | 27,000   |       |
|                                               |       |     |       |     |       |
| Earnings (loss)  before provision for income taxes |       | 66,000   |       | (148,000 | )          |
|                                               |       |     |       |     |       |
| Provision for income taxes                         |       | —   |       | —   |       |
|                                               |       |     |       |     |       |
| Net earnings (loss)                                |       | $        | 66,000     |     | $          | (148,000 | ) |
|                                               |       |     |       |     |       |
| Basic earnings (loss) per share                    |       | $        | .01        |     | $          | (.03 | ) |
|                                               |       |     |       |     |       |
| Diluted earnings (loss) per share                  |       | $        | .01        |     | $          | (.03 | ) |

 

The accompanyingnotes are an integral part of these statements.

 

 

3

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**CONSOLIDATEDSTATEMENTS OF CASH FLOWS (Unaudited)**

Nine Months Ended January 31,

 

 
| ** **                                                                                             | ** ** | **2008** | ** ** | **2007** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Cash flows from operating activities:                                                                  |       |     |       |     |       |
| Net earnings  (loss)                                                                                   |       | $        | 26,000     |     | $          | (353,000 | ) |
| Adjustments to  reconcile net earnings (loss) to net cash provided by (used in) operating  activities: |       |     |       |     |       |
| Cost recognized  on cancellation of restricted stock                                                   |       | 33,000   |       | —   |       |
| Stock  compensation earned                                                                             |       | 37,000   |       | 6,000    |       |
| Depreciation                                                                                           |       | 65,000   |       | 64,000   |       |
| Amortization                                                                                           |       | —   |       | 27,000   |       |
| Change in value  of stock appreciation rights                                                          |       | 27,000   |       | (11,000  | )          |
| Increase  (decrease) in cash flows from operations resulting from changes in:                          |       |     |       |     |       |
| Accounts  receivable                                                                                   |       | 103,000  |       | 14,000   |       |
| Inventories                                                                                            |       | (66,000  | )          | (69,000  | )          |
| Prepaid expenses  and other assets                                                                     |       | (21,000  | )          | (15,000  | )          |
| Trade accounts  payable                                                                                |       | (63,000  | )          | 134,000  |       |
| Accrued  liabilities                                                                                   |       | 21,000   |       | 19,000   |       |
|                                                                                                   |       |     |       |     |       |
| Net cash provided by (used in) operating activities                                                    |       | 162,000  |       | (184,000 | )          |
|                                                                                                   |       |     |       |     |       |
| Cash flows from investing activities:                                                                  |       |     |       |     |       |
| Capital  expenditures                                                                                  |       | (53,000  | )          | (27,000  | )          |
|                                                                                                   |       |     |       |     |       |
| Net cash used in investing activities                                                                  |       | (53,000  | )          | (27,000  | )          |
|                                                                                                   |       |     |       |     |       |
| Cash flows from financing activities:                                                                  |       |     |       |     |       |
| Proceeds from  exercise of incentive stock options                                                     |       | —   |       | 15,000   |       |
| Principal  payments on long-term debt                                                                  |       | (43,000  | )          | (45,000  | )          |
|                                                                                                   |       |     |       |     |       |
| Net cash used in financing activities                                                                  |       | (43,000  | )          | (30,000  | )          |
|                                                                                                   |       |     |       |     |       |
| Net increase in cash                                                                                   |       | 66,000   |       | (241,000 | )          |
| Cash, beginning of period                                                                              |       | 247,000  |       | 521,000  |       |
|                                                                                                   |       |     |       |     |       |
| Cash, end of period                                                                                    |       | $        | 313,000    |     | $          | 280,000 |   |
|                                                                                                   |       |     |       |     |       |
| Supplemental Disclosures of Cash Flow Information                                                      |       |     |       |     |       |
| Cash paid during  the period for:                                                                      |       |     |       |     |       |
| Interest                                                                                               |       | $        | 46,000     |     | $          | 86,000 |   |
| Income taxes  payable                                                                                  |       | $        | —     |     | $          | — |   |

 

The accompanyingnotes are an integral part of these statements.

 

 

4

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**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)**

 

**Note 1 —Nature of Operations**

 

                             Torotel specializes in thecustom design and manufacture of a wide variety of precision magneticcomponents, consisting of transformers, inductors, reactors, chokes andtoroidal coils, for use in commercial, industrial and militaryelectronics.  Torotel also designs anddistributes ballast transformers for the airline industry.  Approximately 94% of Torotel’s sales duringthe first nine months of fiscal 2008 have been derived from domestic customers.

 

**Note 2 —Basis of Presentation**

 

The accompanyingunaudited consolidated financial statements reflect the normal recurringadjustments which in the opinion of management are necessary to present fairlyTorotel’s financial position at January 31, 2008, and the results ofoperations for the three and nine months ended January 31, 2008.

                             The financial statementscontained herein should be read in conjunction with Torotel’s financialstatements and related notes filed on Form 10-KSB for the year ended April 30,2007.

 

**Note 3 —Inventories**

 

                             The components ofinventories are summarized as follows:

 
| Raw materials                                      |   | $592,000 |
|----------------------------------------------------|--------|----------|
| Work in process                                    |   | 191,000  |
| Finished goods                                     |   | 85,000   |
|                                               |   | 868,000  |
| Less: reserve for  obsolete and excess inventories |   | 367,000  |
|                                               |   | $501,000 |

 

 

**Note 4 —Income Taxes**

 

Effective May 1,2007, Torotel adopted the provisions of Financial Accounting Standards BoardInterpretation No. 48 (“FIN 48”), *Accountingfor Uncertainty in Income Taxes - an Interpretation of FASB No. 109,*which clarified the accounting foruncertainty in tax positions*.*  FIN 48 prescribes a recognition threshold andmeasurement attribute for the financial statement recognition and measurementof a tax position taken or expected to be taken in a tax return.  It is management’s responsibility todetermine whether it is more likely than not that a tax position will besustained upon examination, including resolution of any related appeals orlitigation processes, based on the technical merits of the position.  Any resulting cumulative effect of applyingthe provisions of FIN 48 upon adoption would be reported as an adjustment tothe beginning balance of retained earnings and an adjustment to tax liabilitiesin the period of adoption.  Based on athird-party review of prior year federal and state tax returns, Torotel had nounrecognized tax benefits as of May 1, 2007, the income tax positionstaken or expected to be taken for the open tax years are appropriately statedand supported for all open years, and the adoption of FIN 48 did not have amaterial effect on Torotel’s consolidated financial statements for the ninemonths ended January 31, 2008.  Opentax years are April 30, 2003, 2004, 2005 and 2006.

 

 

5

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Torotel would recognizeinterest and penalties accrued on unrecognized tax benefits as well as interestreceived from favorable tax settlements within income tax expense.  At the adoption date of May 1, 2007, andas of January  31, 2008, Torotel recorded no accrued interest or penaltiesrelated to uncertain tax positions. Management expects no significant change in the amount of unrecognizedtax benefit, accrued interest or penalties within the next twelve months.

 

**Note 5 — Share-Based Compensation**

 

Effective May 1, 2006, Torotel adopted the fair value recognitionprovisions of Statement of Financial Accounting Standards No. 123 (revised2004), “Share-Based Payment” (SFAS 123(R)) using the modified prospectivemethod of adoption under the provisions of SFAS No. 148, *Accounting for Stock-Based Compensation — Transitionand Disclosure*.  Prior to May 1,2006, Torotel accounted for all stock option grants under the provisions of APBOpinion 25, *Accounting for Stock Issued toEmployees* and related interpretations; and accounted for all grantsinvolving stock appreciation rights (SARs) under the provisions of SFAS 123using the intrinsic value measurement guidelines of APB Opinion 25.  The adoption of SFAS 123(R) on existingstock option grants did not have any impact on Torotel’s financial condition orresults of operations for the nine months ended January 31, 2007; theadoption of SFAS 123(R) for the SARs resulted in a cumulative effectreduction in stock compensation costs of $8,000 for the same nine-month period.

 

**Note 6 —Employee Stock Options**

 

                             In accordance with theIncentive Compensation Plan approved by shareholders in 1994, Torotel reserved400,000 common shares for issuance to key employees pursuant to the exercise ofincentive stock options granted prior to June 20, 2004.  The incentive stock options had a term offive years when issued and vested 50% per year at the end of each of the firsttwo years.  The exercise price of eachoption equaled the market price of Torotel’s common stock on the date ofgrant.  Accordingly, no compensation costwas recognized for the Plan at the time of grant, and no cost was incurred fromthe adoption of SFAS 123(R) as the outstanding options were fully vestedin 2004.

The fair values of theoptions granted were estimated on the date of grant using the Black-Scholesoptions-pricing model.  The fair value ofthe incentive stock options was determined using the following weighted averageassumptions: no dividend payments over the life of the options; expectedvolatility of 551.0%; risk-free interest rate of 3.50%; and expected life offive years.

                             There are no outstandingstock options as of January 31, 2008. Stock option transactions for the period ended January 31, 2007,are summarized as follows:

 
| ** **                         | ** ** | **2007**                            | ** ** |
|------------------------------------|------------|-------------------------------------|------------|
| ** **                         | ** ** | **Weighted  Shares  Under  Option** | ** ** | **Average  Exercise  Price** | ** ** |
| Outstanding at beginning of period |       | 40,000                              |       | $ | .37 |   |
| Granted                            |       | —                              |       | — |   |
| Exercised                          |       | (40,000                             | )          | $ | .37 |   |
| Forfeited                          |       | —                              |       | — |   |
| Outstanding at end of period       |       | —                              |       | — |   |

 

 

 

6

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**Note7 — Restricted Stock Agreements**

 

RestrictedStock Agreements are authorized by the Compensation and Nominating Committee (“Committee”)and the Board of Directors of Torotel. The Committee and the Board have determined that the interests ofTorotel and its stockholders will be promoted by hiring talented individualsand, to induce such individuals to accept employment with Torotel, theCommittee and the Board believe a key component of such individuals’compensation should be granting equity ownership opportunities based upon theacceptance of employment and the continuing employment of such individual,subject to certain conditions and restrictions.

EffectiveJuly 31, 2006, a Restricted Stock Agreement was entered into betweenTorotel and Benjamin E. Ames, Jr., as part of Mr. Ames’ employment asExecutive Vice President of Torotel Products, Inc., with primaryresponsibilities being new business development.  The amount of the restricted stock award was200,000 shares of common stock, $.01 par value per share.  Based upon Mr. Ames attaining mutuallyagreed upon written annual goals, the restricted shares shall be released fromthe restrictions on transfer and risk of forfeiture in the amount of 40,000shares per year for five years beginning July 31, 2007, and eachanniversary thereof.  Based on the marketprice of $.30 for Torotel’s common stock as of July 31, 2006, the fairvalue of the restricted stock at the date of award was $60,000.  Of this amount, $2,000 was credited to commonstock at par value and the excess of $58,000 was credited to additionalpaid-in capital.  The restrictedshares are treated as non-vested stock pursuant to SFAS 123(R).  Accordingly, an offset amount, classified asunearned stock compensation, is included in the accompanying consolidatedbalance sheet under stockholders’ equity. Stock compensation cost during the three and nine month periods ended January 31,2008 was $3,000 and $9,000, respectively. Stock compensation cost of $3,000 per quarter will be recorded duringthe aggregate five-year vesting period provided the mutually agreed upon goalsare achieved.  As of January 31,2008, 40,000 shares have been released from the restrictions on transfer.

ARestricted Stock Agreement having a measurement date of February 12, 2007,was entered into between Torotel and E. Mark Flynn, as part of Mr. Flynn’semployment as Vice President of Torotel Products, Inc., with primaryresponsibilities being supply chain management and development.  The amount of the restricted stock award was25,000 shares of common stock, $.01 par value per share.  Based on the market price of $.45 for Torotel’scommon stock as of February 12, 2007, the fair value of the restrictedstock at the date of award was $11,250. Of this amount, $250 was credited to common stock at par value and theexcess of $11,000 was credited to additional paid-in capital.  Mr. Flynn’s employment was terminated onOctober 26, 2007.  Stockcompensation cost during the nine month period ended January 31, 2008, was$1,125.  Total stock compensation cost of$1,687.50 had been recognized during the employment period; upon termination,the remaining unearned cost of $9,562.50 was recognized at the time oftermination and the 25,000 shares were transferred to treasury stock.

On August 7, 2007, Restricted Stock Agreementswere entered into between Torotel and 13 key employees pursuant to the StockAward Plan (“SAP”).  The SAP provides keyemployees the opportunity to acquire common stock of Torotel pursuant to awardsearned for accomplishing goals that promote the long-term financial performanceof Torotel.  Under the terms of the SAP,which was filed as Exhibit 10.9 on Form 10-KSB on July 30, 2007,the restricted stock awards have a five (5) year restriction period, whichshall lapse based on certain conditions as outlined in the SAP.  The Restricted Stock Agreements afford thegrantees all of the rights of a stockholder with respect to the award shares,including the right to vote such shares and to receive dividends and otherdistributions payable with respect to such shares since the Date of Award.  The aggregate amount of the restricted stockawards was 575,750 shares of common stock, $.01 par value per share.

 

 

7

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Basedon the market price of $.50 for Torotel’s common stock as of August 7,2007, the fair value of the restricted stock at the date of award was$287,875.  Of this amount, $5,757.50 wascredited to common stock at par value and the excess of $282,117.50 wascredited to additional paid-in capital. The restricted shares are treatedas non-vested stock pursuant to SFAS 123(R). Accordingly, an offset amount, classified as unearned stockcompensation, is included in the accompanying consolidated balance sheet understockholders’ equity.  Stock compensationcost during the three and nine month periods ended January 31, 2008 was$13,168.75 and $27,562.50, respectively. The nine month total included $1,225 associated with the 49,000restricted shares that were issued to E. Mark Flynn as one of the 13 keyemployees.  The unearned cost of $23,275for the 49,000 shares held by Mr. Flynn was recognized at the time of histermination and the 49,000 shares were transferred to treasury stock.  Going forward, stock compensation cost of$13,168.75 will be recorded per quarter during the remaining five-year vestingperiod provided the financial performance metrics as outlined in the SAP arelikely to be attained.

Underthe terms of each agreement, the non-vested shares are restricted as todisposition and subject to forfeiture under certain circumstances.  The agreements provide the employee with allvoting rights with respect to the restricted shares.  The agreements further provide, subject tocertain conditions, that if prior to all of the restricted shares having beenreleased, Torotel undergoes a change in control, then all of the restrictedshares shall be released and no longer subject to restrictions under theagreements.

Restricted stock activityfor each period through January 31 is summarized as follows:

 
| ** **                         | ** ** | **2008**                              | ** ** | **2007**                            |
|------------------------------------|------------|---------------------------------------|------------|-------------------------------------|
| ** **                         | ** ** | **Restricted  Shares  Under  Option** | ** ** | **Weighted  Average  Grant  Price** | ** ** | **Restricted  Shares  Under  Option** | ** ** | **Weighted  Average  Grant  Price** | ** ** |
| Outstanding at beginning of period |       | 225,000                               |       | $                                   | .317 |   | — |   | — |   |
| Granted                            |       | 575,750                               |       | $                                   | .500 |   | 200,000 |   | $ | .300 |   |
| Vested                             |       | (40,000                               | )          | $                                   | .300 |   | — |   | — |   |
| Forfeited                          |       | (74,000                               | )          | $                                   | .483 |   | — |   | — |   |
| Outstanding at end of period       |       | 686,750                               |       | $                                   | .453 |   | 200,000 |   | $ | .300 |   |

 

 

**Note8 — Stockholders’ Equity**

 

The components ofstockholders’ equity are summarized as follows:

 
| Common stock, at par value     |   | $           | 60,000    |   |
|--------------------------------|--------|-------------|-----------|--------|
| Capital in excess of par value |   | 12,613,000  |      |
| Unearned stock compensation    |   | (279,000    | )         |
| Accumulated deficit            |   | (10,915,000 | )         |
|                           |   | 1,479,000   |      |
| Less treasury stock, at cost   |   | 90,000      |      |
|                           |   | $           | 1,389,000 |   |

 

Torotelhas 6,000,000 shares of common stock, $.01 par value, authorized and 5,878,340shares issued and outstanding.  Thechanges in shares of common stock outstanding are summarized as follows:

 
| Balance, May 1, 2007      |   | 5,376,590 |   |
|--------------------------------|--------|-----------|--------|
| Restricted stock  activity     |   | 575,750   |   |
| Treasury stock  activity       |   | (74,000   | )      |
| Balance, January 31, 2008 |   | 5,878,340 |   |

 

 

8

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**Note9 — Earnings Per Share**

 

                             Statement of FinancialAccounting Standards (SFAS) No. 128, *Earningsper Share*, requires dual presentation of basic and diluted EPS onthe face of the statement of operations. It also requires a reconciliation of the numerator and denominator usedin computing basic and diluted EPS. Basic EPS excludes dilution and is computed by dividing earningsavailable to common stockholders by the weighted average number of commonshares outstanding for the period. Diluted EPS is computed similarly to fully diluted EPS pursuant to APBOpinion 15.  Diluted EPS reflects thepotential dilution that could occur if securities or other contracts to issuecommon stock were exercised or converted into common stock or resulted in theissuance of common stock that then shared in the earnings of the entity.  The 686,750 shares issued and outstandingpursuant to the Restricted Stock Agreements (see Note 7 of Notes toConsolidated Financial Statements) meet the definition of contingently issuableshares as outlined in SFAS No. 128; as a result, these shares will not beincluded in the basic EPS calculation until the performance measurements havebeen satisfied.  The restricted sharesare treated as a common stock equivalent for the diluted EPS calculation.  Pursuant to SFAS No. 128, the basic anddiluted earnings per common share were computed as follows:

 

# **Year-to-Date EPS Calculations**

 
| ** **                                                           | ** ** | **2008**  | ** ** | **2007**  | ** ** |
|----------------------------------------------------------------------|------------|-----------|------------|-----------|------------|
| Earnings (loss) before cumulative effect                             |       | $         | 26,000     |      | $          | (361,000 | ) |
| Cumulative effect                                                    |       | —    |       | 8,000     |       |
| Net earnings (loss)                                                  |       | $         | 26,000     |      | $          | (353,000 | ) |
|                                                                 |       |      |       |      |       |
| Weighted average common shares outstanding for basic  EPS            |       | 5,152,395 |       | 5,128,112 |       |
| Incremental shares for effect of stock options and  restricted stock |       | 543,498   |       | —    |       |
| Weighted average common shares outstanding for  dilutive EPS         |       | 5,695,893 |       | 5,128,112 |       |
|                                                                 |       |      |       |      |       |
| Basic and diluted loss per share:                                    |       |      |       |      |       |
| Before  cumulative effect                                            |       | $         | .00        |      | $          | (.07 | ) |
| Cumulative  effect                                                   |       | —    |       | —    |       |
|                                                                 |       | $         | .00        |      | $          | (.07 | ) |

 

 

No incrementalshares are included in the 2007 EPS calculations for the 40,000 shares thatwere under option or the 200,000 shares of restricted common stock since theeffect would be anti-dilutive.

 

# **Quarterly EPS Calculations**

 
| ** **                                                           | ** ** | **2008**  | ** ** | **2007**  | ** ** |
|----------------------------------------------------------------------|------------|-----------|------------|-----------|------------|
| Net earnings (loss)                                                  |       | $         | 66,000     |      | $          | (148,000 | ) |
|                                                                 |       |      |       |      |       |
| Weighted average common shares outstanding for basic  EPS            |       | 5,117,590 |       | 5,151,590 |       |
| Incremental shares for effect of stock options and  restricted stock |       | 686,750   |       | —    |       |
| Weighted average common shares outstanding for  dilutive EPS         |       | 5,804,340 |       | 5,151,590 |       |
|                                                                 |       |      |       |      |       |
| Basic and diluted earnings (loss) per share                          |       | $         | .01        |      | $          | (.03 | ) |

 

No incrementalshares are included in the 2007 EPS calculations for the 200,000 shares ofrestricted common stock since the effect would be anti-dilutive.

 

 

9

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**Note10 — Stock Appreciation Rights**

 

On September 10, 2004, the board of directors of Torotel approvedthe Directors Stock Appreciation Rights Plan (the “Plan”) for non-employeedirectors.  Each SAR is equal to oneshare of common stock of Torotel, and the aggregate number of SARs that may begranted under the Plan shall not exceed 500,000.  The effective date of the Plan is October 1,2004.  The SARs are now accounted forunder SFAS No. 123(R), *Accounting forStock-Based Compensation.*

Pursuant to the Plan,20,000 SARs were granted on the effective date to each of the three currentnon-employee directors serving at that time. The initial price at which each SAR was granted was $.35, which equaledthe market price of Torotel’s common stock on the date of grant.  Accordingly, no compensation cost wasrecognized at the time of grant in accordance with APB Opinion 25, prior to theadoption of SFAS No. 123(R) on May 1, 2006, as discussed in Note5 of Notes to Consolidated Financial Statements.

SARs shall automatically be granted in the future as follows: (1) eachperson who is elected as a director, who was not a director on the effectivedate of the Plan, shall be granted 10,000 SARs on the date such person iselected a director; and (2) on each May 1 following the effectivedate during the term of the Plan, each person serving as a director on suchdate shall be granted 10,000 SARs.  Afterthe initial grant, the price at which each SAR is granted shall be the averageof the closing price of Torotel’s common stock for the ten consecutive daysimmediately preceding the date of grant. Upon exercise of a SAR, Torotel will pay the grantee an amount (the “Spread”)equal to the excess of the Exercise Price over the SAR grant price multipliedby the number of shares being exercised. The Exercise Price shall be the average of the closing price of Torotel’scommon stock for the ten consecutive days immediately preceding the notice ofexercise.  For any payments that exceed$10,000, Torotel has the option to make quarterly payments over three yearswith interest payable quarterly at the prime rate of Torotel’s primary bank.

EachSAR granted hereunder may be exercised to the extent that the Grantee is vestedin such SAR.  The SARs will vestaccording to the following schedule:

 
| **Number of Years the Grantee has remained   a director of the Company following  the Date of Grant** | ** ** | **Shares represented  by a SAR in which  a Grantee is Vested** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| Under one                                                                                             |       | 0                                                              | %          |   |
| At least one but less than two                                                                        |       | 33                                                             | %          |   |
| At least two but less than three                                                                      |       | 67                                                             | %          |   |
| Three or more                                                                                         |       | 100                                                            | %          |   |

 

A Grantee shallbecome fully (100%) vested in each of his or her SARs under the followingcircumstances:  (i) upon terminationof the Grantee’s service as a director of Torotel for reasons of death,disability or retirement; (ii) if the Compensation and NominatingCommittee (the “Committee”), in its sole discretion, determines thatacceleration of the SAR vesting schedule would be desirable for Torotel; or (iii) ifTorotel shall, pursuant to action by its Board of Directors, at any timepropose to merge into, consolidate with, or sell or otherwise transfer all orsubstantially all of its assets to another corporation, and provision is notmade pursuant to the terms of such transaction for the assumption by thesurviving, resulting or acquiring corporation of outstanding SARs or forsubstitution of new SARs therefore, the Committee shall cause written notice ofthe proposed transaction to be given to each Grantee not less than twenty daysprior to the anticipated effective date of the proposed transaction, and his orher SARs shall become fully (100%) vested and, prior to a date specified insuch notice, which shall be not more than ten days prior to the anticipatedeffective date of the proposed transaction, each Grantee shall have the rightto exercise his or her SARs.

 

 

10

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In accordance with SFAS 123(R), compensation expense is recognized overthe vesting period based upon the estimated fair value of the SARs pursuant tothe terms of the Plan using the Black-Scholes options-pricing model as of theend of each financial reporting period. As of January 31, 2008, the fair value of the SARs was determinedusing the following assumptions: no dividend payments over the life of the SARssince Torotel has not issued any form of dividend since 1985; an expectedvolatility of 181.17% based on Torotel’s historical volatility using the weeklyclosing price over the past 3.50 years; a risk-free interest rate of 3.00%; andan expected life of 3.50 years based on the length of service estimated to beserved.  Based on these assumptions, thefair value prices per share of the outstanding SARs are summarized as follows:

 
| **Grant Date**       | ** ** | **SARs  Under  Option** | ** ** | **Exercise  Price** | ** ** | **Fair Value  Price** | ** ** | **%  Vested** | ** ** | **Aggregate  Vested  Fair Value** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|----------------------|------------|-------------------------|------------|---------------------|------------|-----------------------|------------|---------------|------------|-----------------------------------|------------|---------------------------------|------------|
| October 1, 2004 |       | 60,000                  |       | $                   | .350       |                  | $          | .561          |       | 100                               | %          | $                               | 34,000     |   | $ | 15,000 |   |
| May 1, 2005     |       | 30,000                  |       | $                   | .302       |                  | $          | .564          |       | 67                                | %          | $                               | 11,000     |   | $ | 9,000 |   |
| May 1, 2006     |       | 30,000                  |       | $                   | .695       |                  | $          | .545          |       | 33                                | %          | $                               | 6,000      |   | $ | — |   |
| May 1, 2007     |       | 30,000                  |       | $                   | .500       |                  | $          | .553          |       | 0                                 | %          | $                               | —     |   | $ | 3,000 |   |
| June 4, 2007    |       | 10,000                  |       | $                   | .412       |                  | $          | .558          |       | 0                                 | %          | $                               | —     |   | $ | 2,000 |   |

 

The vested portionrepresents 90,000 SARs.  As of January 31,2008, the total aggregate intrinsic value of these exercisable SARs was$24,000.

SARs transactions for each period though January 31 are summarizedas follows:

 
| ** **                         | ** ** | **2008**                  | ** ** | **2007**                              | ** ** |
|------------------------------------|------------|---------------------------|------------|---------------------------------------|------------|
| ** **                         | ** ** | **SARs****Under  Option** | ** ** | **Weighted  Average****Grant  Price** | ** ** | **SARs****Under  Option** | ** ** | **Weighted  Average****Grant  Price** | ** ** |
| Outstanding at beginning of period |       | 120,000                   |       | $                                     | .424       |   | 90,000 |   | $ | .334 |   |
| Granted                            |       | 40,000                    |       | $                                     | .478       |   | 30,000 |   | $ | .695 |   |
| Exercised                          |       | —                    |       | —                                |       | — |   | — |   |
| Forfeited                          |       | —                    |       | —                                |       | — |   | — |   |
| Outstanding at end of period       |       | 160,000                   |       | $                                     | .438       |   | 120,000 |   | $ | .424 |   |
|                               |       |                      |       |                                  |       |   |   |   |   |
| SARs exercisable at end of period  |       | 90,000                    |       | $                                     | .378       |   | 50,100 |   | $ | .341 |   |
| Weighted average fair value of     |       |                      |       |                                  |       |   |   |   |   |
| SARs granted  during the period    |       |                      |       | $                                     | .554       |   |   |   | $ | .419 |   |

 

 

The following informationapplies to SARs outstanding for each period through January 31:

 
| ** **                                  | ** ** | **2008**  | ** **   | **2007**  | ** ** |
|---------------------------------------------|------------|-----------|--------------|-----------|------------|
| Number outstanding                          |       | 160,000   |         | 120,000   |       |
| Range of grant prices                       |       | $         | .302 - $.695 |      | $          | .302 - $.695 |   |
| Weighted average grant price                |       | $         | .438         |      | $          | .424 |   |
| Weighted average remaining contractual life |       | 7.72 yrs. |         | 8.21 yrs. |       |

 

 

Total compensationexpense for the outstanding SARs for the nine months ended January 31,2008 was $27,000.  Total compensationexpense for the outstanding SARs for the nine months ended January 31, 2007

 

 

11

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was a reduction of$3,000.  The amount for 2006 was net ofan $8,000 reduction for the cumulative effect of adopting SFAS No. 123 (R).  Total compensation expense for theoutstanding SARs for the three months ended January 31, 2008 was$12,000.  Total compensation expense forthe outstanding SARs for the three months ended January 31, 2007 was areduction of $11,000.  As of January 31,2008, there was $38,000 of total unrecognized compensation expense related tonon-vested SARs granted under the Plan. That cost is expected to be recognized over a weighted average period of..85 years.  The liability for SARs on theconsolidated balance sheet as of January 31, 2008, was $51,000.

 

**Note 11 — Related Party Event**

 

The purchase option settlement agreement with the Caloyeras FamilyPartnership, filed as Exhibit 10.1 on Form 8-K on April 20,2007, and incorporated herein by reference, expired on July 31, 2007.  The litigation that was part of thesettlement agreement can be re-filed as a result of the expiration.

 

**Note 12 — Concentrations of CreditRisk**

 

Financial instruments that potentially subject Torotel toconcentrations of credit risk consist principally of cash and accountsreceivable.  Torotel grants unsecuredcredit to substantially all of its customers. Management does not believe that it is exposed to any extraordinarycredit risk as a result of this policy. Torotel deposits all monies at the Bank of Blue Valley.  These accounts are secured up to $100,000 bythe Federal Deposit Insurance Corporation. At various times and at January 31, 2008, these cash balancesexceed federally insured limits.  Torotelhas not experienced any losses in such accounts.  Management does not believe Torotel isexposed to any significant credit risk with respect to its cash and cashequivalents.

 

**Note 13 — Financing Agreement**

 

On September 30,2007, Torotel Products renewed its $200,000 revolving credit agreement withBank of Blue Valley.  Advances under thecredit line are limited to 75% of eligible billed receivables.  The revolving line is collateralized by theland and buildings in Olathe, Kansas. Under the terms of the agreement, the outstanding balance of therevolving line bears interest at 1.25% over the bank’s corporate base rate andhas a maturity date of September 30, 2008. As of January 31, 2008, the effective borrowing rate was 7.75% andthe entire credit line was available.

 

 

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**Item 2.****                    ****Management’s Discussionand Analysis or Plan of Operation**

 

*Overview*

 

                             Torotel conducts business primarilythrough two wholly owned subsidiaries, Torotel Products and Electronika.  In addition, Torotel has a 12.88% equityinterest in Apex.

          Torotel Products designsand manufactures a wide variety of magnetic components for use in military,aerospace and industrial electronic applications.  These magnetic components, which consist oftransformers, inductors, reactors, chokes, and toroidal coils, are used tomodify and control electrical voltages and currents in electronic devices.  For example, if equipment containing one ofthese components receives an electrical voltage or current which is too highfor proper operation of the equipment, the component would modify and controlthe electrical voltage or current to allow proper operation of theequipment.  While Torotel Productsprimarily manufactures the components in accordance with pre-developedmechanical and electrical requirements, in some cases it will be responsiblefor both the overall design and manufacture of the components.  The magnetic components are sold tomanufacturers who incorporate them into an end-product.  The major applications include aircraftnavigational equipment, voice and data secure communications, medicalequipment, avionics equipment, and conventional missile guidance systems.

Torotel Products markets its components primarilythrough a 4-person internal sales force, which includes a Vice President ofBusiness Development that was hired in July 2006, and four independentmanufacturers’ representatives paid on a commission basis.  Torotel Products also utilizes its 4-personengineering department in its direct sales efforts for the purpose of expandingits reach into new markets and/or customers.

                             Torotel Products is an approved sourcefor magnetic components used in numerous military and aerospace systems, whichmeans Torotel Products is automatically solicited for any procurement needs forsuch applications.  The magnetic componentsmanufactured by Torotel Products are sold primarily in the United States, andmost sales are awarded on a competitive bid basis.  The markets in which Torotel Productscompetes are highly competitive.  Asubstantial number of companies sell components of the type manufactured andsold by Torotel Products.  In addition,Torotel Products sells to a number of customers who have the capability ofmanufacturing their own electronic components. The principal methods of competition for electronic products in themarkets served by Torotel Products include, among other factors, price, on-timedelivery performance, lead times, customized product engineering and technicalsupport, marketing capabilities, quality assurance, manufacturing efficiency,and existing relationships with customers’ engineers.  While magnetic components are not susceptibleto rapid technological change, Torotel Products’ sales, which do not representa significant share of the industry’s market, are susceptible to decline giventhe competitive nature of the market.

Electronika is a marketing and licensing companyselling ballast transformers to the airline industry.  These transformers activate and control thelights in commercial airplane cockpits. Electronika’s ballast transformers are approved as spare and replacementparts in DC-8, DC-9, DC-10, MD-80 and MD-88 aircraft; however, sales of ballasttransformers have been made primarily for use in DC-8 and DC-9 aircraft.  As a result, the business of Electronika issubject to various risks including, without limitation, any decline in use ofthe referenced aircraft, and competition for the available spare partsbusiness.  Electronika’s sales do notrepresent a significant portion of any particular market.

 

 

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Electronika’s requirements for the ballast transformers are outsourcedpursuant to a Manufacturing Agreement with Magnetika, a corporation owned bythe Caloyeras family.  Under the terms ofthe agreement, Magnetika provides all necessary raw material, labor, testing,packaging and related services required to complete the manufacture, deliveryand sale of the ballast transformers. Electronika retains ownership of all designs, drawings, specificationsand intellectual property rights associated with the ballast transformers.  Magnetika is a manufacturing company that, inaddition to the aforementioned ballast transformers, manufactures various otherproducts similar to those of Torotel for other unrelated customers.  Magnetika’s annual sales are estimated to beabout two times the annual sales of Torotel. Total purchases of goods from Magnetika by Electronika amounted to$11,000 for the nine months ended January 31, 2008.

 

*Business Outlook*

 

The sales mix for the first nine months of fiscal 2008was 50% defense, 37% aerospace and 13% commercial/industrial.  Management believes that the mix in fiscal2009 should shift more toward defense as higher demand for the potted coilassembly for the Hellfire II missile system is scheduled.  In addition, management believes expandedselling and marketing efforts within our existing major customer base shouldyield a number of opportunities in other military programs.  Management also believes the aerospace segmentshould continue to be a strong market, especially with the major suppliers ofthe Boeing 787 Dreamliner and the 737 series. New order bookings in the first nine months of fiscal 2008 increasednearly 32% over the prior year period, exclusive of the $2.1 million contractfor the potted coil assembly awarded in last year’s first half.  In February 2008, Torotel was awardedanother contract for the potted coil assembly valued at $3.25 million withshipments scheduled through June 2009. As a result, management anticipates an overall increase in new orderbookings of approximately 35% for fiscal 2008. The primary factors that drive gross profit and net earnings for TorotelProducts are sales volume and product mix. The gross profits on mature products/programs and larger transformerdevices tend to be higher than those that are still in the prototyping or earlyproduction stages and simpler inductor devices. As a result, in any given accounting period the mix of product shipmentsbetween higher and lower margin jobs has a significant impact on the grossprofit and net earnings of Torotel Products.

Torotel’s operating plan called for additional salesand marketing costs in the form of personnel and/or commissions and trade showexhibits.  Management has also investedmore training dollars toward workforce development as part of the ongoingefforts to improve Torotel’s processes and value streams.  Management believes a well developed growthstrategy is in place and that going forward, some or all of these expenditureswill be necessary on a continuing basis in order to achieve the desiredgrowth.  Future annual earnings willcontinue to be impacted by increased auditing costs associated with complyingwith SEC regulations and the standards of the Public Company AccountingOversight Board (United States) and Sarbanes-Oxley Section 404compliance.  Torotel’s management willcontinue to focus its efforts in areas and solutions that they believe offersignificant growth, which includes expanding the product base beyond electroniccomponents.  The aircraft manufacturerscontinue to book orders at a record pace with substantial backlog through atleast the end of the decade; Torotel will continue to expand its sales andmarketing efforts in this area.  Management’s goal continues to be “9-by-9”, which is to reach a revenuelevel of $9 million by fiscal year 2009. The key to reaching this goal is the anticipated award of a sub-assemblycontract with a new customer.

Electronika’s net sales continue to be impacted by thedecline in the number of active DC-8 and DC-9 aircraft.  Management expects these sales to continue todecline and eventually phase out.

 

 

14

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*Resultsof Operations*

 

                             The following management comments regarding Torotel’sresults of operations and outlook should be read in conjunction with theConsolidated Financial Statements included pursuant to Item 1 of this QuarterlyReport.

The discussion andanalysis of the results of operations include the operations of Torotel, Inc.and its subsidiaries, Torotel Products, Inc. and Electronika, Inc.  While each company’s results are included inthe following discussion, segment reporting is not applicable because theproducts offered are similar in form and function, and target similar markets.

 

**Nine MonthsEnded January 31, 2008 Compared With Nine Months Ended January 31,2007**

 

Net sales increased 22%.  The net sales of Torotel Products increased 24% from $3,549,000 to $4,413,000.  This increase is attributable to higher demand for components used in certain aerospace and military applications, and higher shipments of the potted coil assembly for the Hellfire II missile system.  The net sales of Electronika decreased 66% from $82,000 to $28,000.  This decrease is attributable to delayed shipments caused by an encapsulating material becoming obsolete and the time involved in getting an alternate material approved by Boeing.  This delay could continue for a few months, but it will not have a significant impact on Torotel’s consolidated operating results given the expected downward trend in Electronika’s sales.  The backlog of orders affected is $59,000.

Gross profit as a percentage of net sales increased nearly 4%.  The gross profit percentage of TorotelProducts increased 4% primarily because of higher sales volume.  Electronika’s gross profit as a percentage ofnet sales remained unchanged.

                             Engineering expenses, applicable only toTorotel Products, increased slightly from $193,000 to $196,000.  Management does anticipate an increase in thepresent level of engineering expenses during the next few quarters asadditional engineering technical support is planned.

                             Selling, general and administrative(SG&A) expenses increased nearly 10%. The SG&A expenses of Torotel, Inc. decreased 4% from $338,000to $324,000 primarily because of a $51,000 decrease in  professional fees associated with litigationfiled in the prior year by the Caloyeras Family Partnership and a $13,000decrease in consulting costs incurred in the prior year for short and long-termcompensation planning.  These decreaseswere offset partially by a $30,000 increase in the costs recognized for thefair value of stock appreciation rights and a $20,000 increase in auditingfees.  The SG&A expenses of TorotelProducts increased 16% from $1,055,000 to $1,226,000 primarily because of a$64,000 increase in stock compensation costs, a $50,000 increase in payrollcosts, a $43,000 increase in training costs, an $11,000 increase in fastpay-discounts to major customers and an $11,000 increase in sales commissions.  These increases were offset partially by an$8,000 decrease in bank charges associated with the write-off in the prior yearof capitalized loan fees on the original mortgage loan for the Olathe facility.  The SG&A expenses of Electronikadecreased $22,000 because of the expiration of the monthly management feepursuant to the terms of the manufacturing agreement with Magnetika.  Management does anticipate a decrease in thepresent level of SG&A expenses for the balance of fiscal 2008.

                             Amortization costs, entirely attributableto Electronika, decreased $27,000 as the intangible assets are fully amortized.

 

 

15

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Interest expense decreased nearly 47%. The interest expense of Torotel, Inc. decreased $39,000 because ofthe retirement of the note payable to shareholder.  The interest expense of Torotel Products decreasedfrom $47,000 to $46,000 because of a lower debt balance.

Interest income decreased $7,000 because of less fundsset aside in a money management account.

For the reasonsdiscussed above, the consolidated pretax earnings increased from a loss of$361,000 to a profit of $26,000.  Thepretax loss of Torotel, Inc. decreased from $377,000 to $324,000.  The pretax earnings of Torotel Products increasedfrom $13,000 to $333,000.  The pretaxearnings of Electronika increased from $3,000 to $17,000.

 

**ThreeMonths Ended January 31, 2008 Compared With Three Months Ended January 31,2007**

 

Net sales increased nearly 22%.  The net sales of Torotel Products increased 26% from $1,106,000 to $1,392,000.  This increase is attributable to higher demand for components used in certain aerospace and military applications, and higher shipments of the potted coil assembly for the Hellfire II missile system.  The net sales of Electronika decreased 100% from $39,000 to zero.  This decrease is attributable to delayed shipments caused by an encapsulating material becoming obsolete and the time involved in getting an alternate material approved by Boeing.  This delay could continue for a few months, but it will not have a significant impact on Torotel’s consolidated operating results given the expected downward trend in Electronika’s sales.

Gross profit as a percentage of net sales increased 3%.  The gross profit percentage of TorotelProducts increased nearly 4% primarily because of higher sales volume.  Electronika’s gross profit as a percentage ofnet sales decreased 100% because of not having any sales.

                             Engineering expenses, applicable only toTorotel Products, increased slightly from $64,000 to $65,000.  Management does anticipate an increase in thepresent level of engineering expenses during the next few quarters asadditional engineering technical support is planned.

                             Selling, general and administrative(SG&A) expenses decreased 11%.  TheSG&A expenses of Torotel, Inc. decreased 46% from $87,000 to $47,000primarily because of a $73,000 decrease in professional feesassociated with litigation filed in the prioryear by the Caloyeras Family Partnership. This decrease was offset partially by a $23,000 increase in the costsrecognized for the fair value of stock appreciation rights and a $10,000increase in auditing fees.  The SG&Aexpenses of Torotel Products decreased 1% from $379,000 to $375,000 primarilybecause of a $23,000 decrease in training costs and $9,000 decrease in travelcosts.  These decreases were offsetpartially by a $13,000 increase in stock compensation costs, a $12,000 increasein recruiting costs and a $3,000 increase in sales commissions.  The SG&A expenses of Electronikadecreased $7,000 because of the expiration of the monthly management feepursuant to the terms of the manufacturing agreement with Magnetika.  Management does anticipate a decrease in thepresent level of SG&A expenses for the balance of fiscal 2008.

                             Amortization costs, entirely attributableto Electronika, decreased $16,000 as the intangible assets are fully amortized.

                             Interest expense decreased 48%.  The interest expense of Torotel, Inc.decreased $13,000 because of the retirement of the note payable toshareholder.  The interest expense ofTorotel Products decreased from $16,000 to $15,000 because of a lower debtlevel.

Interest income decreased $2,000 because of less fundsset aside in a money management account.

 

 

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For the reasons discussed above, the consolidated pretax earningsincreased from a loss of $148,000 to a profit of $66,000.  The pretax loss of Torotel, Inc.decreased from $100,000 to $47,000.  Thepretax earnings of Torotel Products increased from a loss of $49,000 to aprofit of $113,000.  The pretax earningsof Electronika decreased from $1,000 to breakeven.

 

**Liquidityand Capital Resources**

 

                             As of January 31, 2008, Torotel had$313,000 in cash and cash equivalents compared to $280,000 as of January 31,2007.  Management expects cash flow fromoperations to improve during the balance of fiscal 2008 because of the currentshippable backlog position, utilization of a fast-pay service offered bycertain major customers and lower corporate expenses for the remainder offiscal 2008.

The table below presents the summary of cash flow for the nine-month periods indicated.

 
| ** **                                          | ** ** | **2008** | ** ** | **2007** | ** ** |
|-----------------------------------------------------|------------|----------|------------|----------|------------|
| Net cash provided by (used in) operating activities |       | $        | 162,000    |     | $          | (184,000 | ) |
| Net cash used in investing activities               |       | $        | (53,000    | )        | $          | (27,000 | ) |
| Net cash used in financing activities               |       | $        | (43,000    | )        | $          | (30,000 | ) |

 

 

Net cash provided by orused in operating activities fluctuates between periods primarily as a resultof differences in operating earnings, the timing of shipments and thecollection of accounts receivable, changes in inventory, level of sales andpayment of accounts payable.  The $53,000of cash used in investing activities was the result of capitalexpenditures.  Management anticipatesapproximately $60,000 in total capital expenditures during fiscal 2008.  Net cash used in financing activities isbecause of payments on long-term debt. Management believes that the projected cash flow from operations,combined with its existing cash balances, will be sufficient to meet itsfunding requirements for the foreseeable future.  Torotel does have a $200,000 bank line ofcredit available, which could be utilized to help fund any working capitalrequirements.

                             Return on Capital Employed (“ROCE”) is the primarytool for managing Torotel’s business. ROCE is measured by the following formula:

** **
| **Earnings  before interest and taxes (EBIT)**       | ** ** | **X**      | ** ** | **Net  Sales**                                                    | **=**      | **ROCE**   | ** ** |
|------------------------------------------------------|------------|------------|------------|-------------------------------------------------------------------|------------|------------|------------|
| **Net  Sales**                                       | ** ** | ** ** | ** ** | **Net  Operating Assets (NOA)**                                   | ** ** | ** ** |
| ** **                                           | ** ** | ** ** | ** ** | ** **                                                        | ** ** | ** ** |
| **Measures profit and loss management**              | ** ** | ** ** | ** ** | **Measures balance sheet management**                             | ** ** | ** ** |
| ** **                                           | ** ** | ** ** | ** ** | ** **                                                        | ** ** | ** ** |
| **Profitability %**                                  | ** ** | ** ** | ** ** | **Activity rating**                                               | ** ** | ** ** |
| ** **                                           | ** ** | ** ** | ** ** | ** **                                                        | ** ** | ** ** |
| **Measures how much profit in each dollar of sales** | ** ** | ** ** | ** ** | **Measures how much sales is generated from each  dollar of NOA** | ** ** | ** ** |
| ** **                                           | ** ** | ** ** | ** ** | ** **                                                        | ** ** | ** ** |
| **Quality of Revenue**                               | ** ** | ** ** | ** ** | **Quantity of Revenue**                                           | ** ** | ** ** |

** **

ROCE measures what youget out (EBIT) versus what you put in (NOA = Capital Employed).  For these purposes, NOA is defined as “accountsreceivable + inventory + net fixed assets + miscellaneous operating assets —accounts payable — miscellaneous operating liabilities”.  The performance of Torotel’s management

 

 

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and the majority of itsdecisions going forward will be measured by whether Torotel’s ROCEimproves.  In fiscal 2005, 2006 and 2007,Torotel’s ROCE was 5.84%, 19.04% and -.66%, respectively.  Torotel’s ROCE for the 12-month trailingperiod ended January 31, 2008 was 18.26%.

 

**CriticalAccounting Policies**

 

*Use ofEstimates*

 

          The preparation of the consolidated financial statements inconformity with accounting principles generally accepted in the United Statesof America requires management to make estimates and assumptions that affectcertain reported amounts and disclosures. Significant estimates used in preparing these consolidated financialstatements include those assumed in computing the carrying value of equipment,allowance for doubtful accounts receivable, reserve for obsolete and excessinventory, the valuation allowance on deferred tax assets and the reserve forwarranty costs.  Accordingly, actualresults could differ from those estimates. Any changes in estimates are recorded in the period in which they becomeknown.

 

*CreditRisk*

 

Financial instrumentsthat potentially subject Torotel to concentrations of credit risk consistprincipally of cash and accounts receivable. Torotel grants unsecured credit to substantially all of itscustomers.  Management does not believethat it is exposed to any extraordinary credit risk as a result of thispolicy.  Torotel deposits all monies atthe Bank of Blue Valley.  These accountsare secured up to $100,000 by the Federal Deposit Insurance Corporation.  At various times and at January 31,2008, these cash balances exceed federally insured limits.  Torotel has not experienced any losses insuch accounts.  Management does notbelieve Torotel is exposed to any significant credit risk with respect to itscash and cash equivalents.

 

*FairValue of Financial Instruments*

 

                             Cost approximates market for all financial instrumentsas of January 31, 2008 and 2007.

 

*TreasuryStock*

 

                             Torotel utilizes the weighted average cost method inaccounting for its treasury stock transactions.

 

*RevenueRecognition*

 

                             Revenue is recognized on contracts and orders on thedate the product is shipped to the customer (unit-of-delivery method).  Torotel’s annual consolidated sales arisingfrom contracts having deliveries scheduled over a period of more than one yearfor fiscal years 2007 and 2006 were approximately 23% and 20%, respectively,because of the contracts for the potted coil assembly.

 

 

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*Allowancefor Doubtful Accounts*

 

Gross trade accountsreceivable are offset with an allowance for doubtful accounts.  The allowance for doubtful accounts ismanagement’s best estimate of the amount of probable credit losses in Torotel’sexisting accounts receivable.  Managementreviews the allowance for doubtful accounts on a regular basis, and all pastdue balances are reviewed individually for collectibility.  Account balances are charged against theallowance when placed for collection. Recoveries of receivables previously written off are recorded whenreceived.  The majority of the customeraccounts are considered past due after the invoice becomes older than thecustomer’s credit terms.  Interest is notcharged on past due accounts.

 

*Inventories*

 

                             Inventories are stated at the lower of cost ormarket.  Cost is determined using amoving average cost method of valuation that currently and historicallyapproximates the first-in, first-out method. Torotel’s industry is characterized by short-term customer commitmentsand changes in demand, as well as other market considerations.  Provisions for estimated obsolete and excessinventory are based on reviews of inventory usage, quantities on hand andlatest product demand information from customers.  Inventories are reviewed in detail utilizinga 12-month time horizon.  Individual partnumbers that have not had any usage in a 12-month time period are categorizedas obsolete; individual part numbers having more than a 12-month supply basedon the current year’s usage are categorized as excess.  The reserve balance is analyzed for adequacyalong with the inventory review each quarter.

 

*Property,Plant and Equipment*

 

                             Property, plant and equipment are carried atcost.  Depreciation and amortization areprovided in amounts sufficient to relate the costs of depreciable assets tooperations primarily using the straight-line method over estimated useful livesof three to five years for property and equipment, and ten to twenty years forbuildings and improvements.

 

*CashFlows*

 

                             For purposes of the statements of cash flows, Torotelconsiders all short-term investments purchased with original maturity dates ofthree months or less to be cash equivalents.

 

*EquityInvestment in Apex*

 

Torotel has a 12.88%interest in Apex.  The investment in Apexhas no carrying value on the consolidated balance sheet of Torotel, and in theopinion of Torotel management, it is not likely that any of the investment willbe recovered because of Apex’s continued financial losses.  If Apex were to eventually be sold, any cashrecovered would be recognized as a gain upon receipt of the proceeds.

 

 

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*WarrantyCosts*

 

Torotel has a reserve forestimated warranty costs associated with products returned from customers.  A limited warranty is provided for a periodof one year which requires Torotel to repair or replace defective products atno cost to the customer.  The warrantyreserve is based on historical experience and reflects management’s bestestimate of probable liability under the product warranties.

 

*Share-BasedCompensation*

 

Effective May 1, 2006, Torotel adopted the fair value recognitionprovisions of Statement of Financial Accounting Standards No. 123 (revised2004), “Share-Based Payment” (SFAS 123(R)) using the modified prospectivemethod of adoption under the provisions of SFAS No. 148, *Accounting for Stock-Based Compensation — Transitionand Disclosure*.  Prior to May 1,2006, Torotel accounted for all stock option grants under the provisions of APBOpinion 25, *Accounting for Stock Issued toEmployees* and relatedinterpretations; and accounted for all grants involving stock appreciationrights (SARs) under the provisions of SFAS 123 using the intrinsic valuemeasurement guidelines of APB Opinion 25. The adoption of SFAS 123(R) on existing stock option grants did nothave any impact on our financial condition or results of operations for thenine months ended January 31, 2007; the adoption of SFAS 123(R) forthe SARs resulted in a cumulative effect reduction in stock compensation costsof $8,000 for the same nine-month period.

 

**Forward-LookingInformation**

 

                             *This report, as well asour other reports filed with the Securities and Exchange Commission (“SEC”),and in press releases and other public communications throughout the year,contains forward looking statements made pursuant to the safe harbor provisionsof The Private Securities Litigation Reform Act of 1995.  The words “believe,” “estimate,” “anticipate,”“project,” “intend,” “expect,” “plan,” “outlook,” “forecast,” “may,” “will,” “should,”“continue,” “predict” and similar expressions are intended to identify forwardlooking statements.  This report containsforward-looking statements regarding, among other topics, our expectedfinancial position, results of operations, cash flows, strategy, budgets andmanagement’s plans and objectives. Accordingly, these forward-looking statements are based on assumptionsabout a number of important factors. While we believe that our assumptions about such factors are reasonable,such factors involve risks and uncertainties that could cause actual results tobe different from what appear here. These risk factors include: the ability to adequately pass through tocustomers unanticipated future increases in raw material costs, decreaseddemand for products, delays in developing new products, expected orders that donot occur, loss of key customers, the impact of competition and price erosion aswell as supply and manufacturing constraints, and other risks anduncertainties.  In light of these risksand uncertainties, there can be no assurance that the forward-lookinginformation contained in this report will prove accurate, and our actual resultsmay differ materially from these forward looking statements.  We assume no obligation to update anyforward-looking statements made herein.*

 

 

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Item 3.                       Controls and Procedures

 

Torotel’s Chief Executive Officer and Chief Financial Officer(collectively, the “Certifying Officers”) are responsible for establishing andmaintaining disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e))for Torotel.  Such officers haveconcluded (based upon their evaluation of these controls and procedures as ofthe end of the period covered by this report) that Torotel’s disclosurecontrols and procedures are adequate and effective for purposes of Rule 13a-15(e) intimely alerting them to material information relating to Torotel required to beincluded in Torotel’s filings with the SEC under the Securities Exchange Act of1934.

The Certifying Officers also have indicated that there were no changesduring the period covered by this report in Torotel’s internal controls overfinancial reporting or other factors that have materially affected, or arereasonably likely to materially affect such controls, and there were nocorrective actions with regard to significant deficiencies and materialweaknesses.

 

 

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**PART II.****         ****OTHER INFORMATION**

 

**Item 4.****                    ****Submission of Matters to a Voteof Security Holders**

 

The annual meeting of shareholders was held in Kansas City, Missouri,on Monday, October 15, 2007, to vote on:

 

a.                    The following two management proposals:

 

(1)              To elect two members to serve on theBoard of Directors for a three-year term, with those nominees receiving thegreatest number of votes being elected; and

 

(2)             To approve an amendment to the Torotel’sArticles of Incorporation to increase the number of authorized shares of commonstock, par value $.01 per share, from 6,000,000 to 20,000,000 shares, with theaffirmative vote of a majority of the shares of common stock present, in personor by proxy, and entitled to vote required to approve this proposed amendment.

 

b.                   The following three shareholderproposals:

 

(3)             To consider and vote upon a shareholderproposal that permits only shareholders to make, alter, amend, suspend orrepeal the Corporation’s By-Laws;

 

(4)             To consider and vote upon a shareholderproposal to revoke a provision of the Corporation’s By-Laws to remove advancenotice requirements for shareholders to bring business before a shareholdermeeting; and

 

(5)             To consider and vote upon a shareholderproposal to reduce the number of members on the Board of Directors from sevento five.

 

A majority of the outstanding shares of common stock entitled to bevoted at the meeting, represented in person or by Proxy, was necessary toconstitute a quorum to transact business at the meeting.  At the meeting, there were 4,208,413 sharesrepresented which was 70.70% of the shares outstanding and eligible to vote.  The voting results were as follows:

 

***Proposal 1***.                        Shareholders elected the followingindividuals to a three-year term on the Board of Directors, with the number ofshares voting “FOR” each nominee indicated.

 

| Anthony H. Lewis   |   | 3,049,329 |   |
|--------------------|--------|-----------|--------|
| Stephen K. Swinson |   | 3,048,972 |   |

 

In addition to thedirectors elected above, S. Kirk Lambright, Jr., H. James Serrone, Dale H.Sizemore, Jr. and Richard A. Sizemore also serve as directors.  The current three-year term for Messrs. Lambrightand Serrone ends in 2008, while the three-year term for Messrs. Sizemoreends in 2009.

 

***Proposal 2.******                       ***Shareholders rejected the amendment toincrease the number of authorized shares of common stock, with the number ofshares voting “FOR” , “AGAINST”, and “ABSTAIN” indicated below.

 

| FOR     |   | 2,747,437 |   |
|---------|--------|-----------|--------|
| AGAINST |   | 1,399,101 |   |
| ABSTAIN |   | 61,875    |   |

 

 

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***Proposal 3.       ***Shareholders rejected the shareholderproposal that permits only shareholders to make, alter, amend, suspend orrepeal the Corporation’s By-Laws, with the number of shares voting “FOR” , “AGAINST”,and “ABSTAIN” indicated below.

 

| FOR     |   | 1,079,338 |   |
|---------|--------|-----------|--------|
| AGAINST |   | 2,197,953 |   |
| ABSTAIN |   | 60,489    |   |

 

***Proposal 4.       ***Shareholders rejected the shareholderproposal to revoke a provision of the Corporation’s By-Laws to remove advancenotice requirements for shareholders to bring business before a shareholdermeeting, with the number of shares voting “FOR” , “AGAINST”, and “ABSTAIN”indicated below.

 

| FOR     |   | 1,074,583 |   |
|---------|--------|-----------|--------|
| AGAINST |   | 2,202,708 |   |
| ABSTAIN |   | 60,489    |   |

 

***Proposal 5.       ***Shareholders rejected the shareholderproposal to reduce the number of members on the Board of Directors from sevento five, with the number of shares voting “FOR” , “AGAINST”, and “ABSTAIN”indicated below.

 

| FOR     |   | 1,060,489 |   |
|---------|--------|-----------|--------|
| AGAINST |   | 2,218,397 |   |
| ABSTAIN |   | 58,894    |   |

 

**Item6.   Exhibits**

 

a)                Exhibits

 

| Exhibit 31.1 |   | Officer Certification                                                                                                              |
|-------------------|--------|------------------------------------------------------------------------------------------------------------------------------------|
| Exhibit 31.2 |   | Officer Certification                                                                                                              |
| Exhibit 32.1 |   | Certification  Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002 |
| Exhibit 32.2 |   | Certification  Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002 |

 

 

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**SIGNATURES**

 

 

In accordance with therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.

 

 

**Torotel, Inc.**

**(Registrant)**

 

 
| /s/ Dale H.  Sizemore, Jr. |   |
|---------------------------------|--------|
| Dale H.  Sizemore, Jr.     |   |
| Chief Executive Officer         |   |
| Date:  March 17, 2008 |   |
|                            |   |
|                            |   |
| /s/ H. James Serrone            |   |
| H. James Serrone                |   |
| Chief Financial Officer         |   |
| Date:  March 17, 2008 |   |

 

 

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